BEP and Tax Avoidance - Government looks for more revenue

This article looks at the international developments seeking to address the erosion of the tax base and at other moves being made by Government to increase revenue.

Governments are looking for more tax Revenue

Given the state of government indebtedness around the western world the question of taxation and in particular raising the level of a Government’s tax take is front and centre. There are several ways in which Governments can raise their tax take. They can for example:

raise the tax rate. Under such a strategy the rate of income tax could for example be increased from 33% to 66%.

introduce new taxes. The 1985 introduction of GST was an example of that as is the financial transactions tax, which the EU is intending to introduce.

increase the tax base. Using this approach the number of taxpayers is increased and/or the type of economic activity that is taxed is increased.

decrease harmful tax practices, which erode the tax base.

This article looks at all 4 of these approaches given the topical initiatives that are on foot or have been mooted recently and discarded.

With respect to the first approach, the problem is that while the Government’s tax take goes up there are often negative political consequences associated with rates rises. That is not to say that the public is so individualistically minded that any tax rate raise is always political suicide. For example opinion polls around the time of the Christchurch earthquake showed that the public would have supported an increase in the tax rate to pay for the Christchurch rebuild. More subtle versions of this approach are to have a progressive tax rate system expressed in nominal dollar terms with no inflation adjustment mechanism. A nominal progressive tax rate system means that over time more and more people pay tax at the highest marginal tax rate. The concept is called fiscal drag and while politicians have been aware of this for years, none have ever sought to fix the problem.

With respect to the second approach the introduction of any new taxes carries the same political problems as a tax rate raise does and hence occur relatively infrequently. The most obvious tax that New Zealand does not have compared to comparative jurisdictions is a capital gains tax. At some point that may need to be considered. Recently, there have been some base broadening measures proposed, in respect of which the opponents have labelled “new taxes”. All have been dropped. I will mention them when discussing the third approach below.

With respect to the third example there have been attempts in New Zealand over the last 12 months to increase the tax take by broadening the tax base in the sense of enlarging the scope of items that will be taxed. The first example was with what has been colloquially called the “car park” tax. It was a proposal which came to light within a group of proposals to review the way in which salary trade-offs are treated. The proposal was that they should be treated as income. By changing the way in which salary trade-offs are taxed the tax take can be increased without the headline tax rate changing.

Such moves also have the presentational advantage of being able to be proposed as measures to increase fairness and make sure that all citizens bear their intended share of the load. This particular initiative also had a cost savings component because some people were in receipt of taxpayer funded assistance because the form of “income” they received was not recognised as income for tax purposes. While some benefits were subject to FBT in the hands of employers, those amounts were not always recognised as income in social services legislation. Hence to a certain extent the review was not about raising???rising tax but managing expenditure.

The FBT rules did not tax on-site car parks provided by employers to employees for free or subsidise on-site child care. The proposals intended to tax these benefits. These aspects of the proposals were accordingly all about increasing the tax take. The proposed enlargement of the taxation net were flown by officials almost exactly a year ago. While the popular media has suggested that there was thundering silence from the tax profession on this issue, the profession was in fact engaging in the submission process.

As a result of those submissions the Government proposed the “car park tax” would specifically target car parks in the Wellington / Auckland CBD (where the benefit to employees was deemed to be greatest) and it would exclude car parks used for work vehicles, late night shifts and disabled car parks and allow a standard value to apply if the car park is not provided through a commercial car park operator (this was aimed at reducing compliance costs to employers). Charities would be exempt. When it became apparent that the new “car park tax” would only raise about $17 million in tax revenue a year the Government decided to drop the idea. The tax gain was not worth the political pain.

Another example of similar failed moves to increase the amount of tax raised concerned the use of smart phones and laptops. The move to include the benefit of the personal use of such devices in the tax base became known as the “ipad tax”. The” ipad tax” revenue raising initiative was dropped as well.

A fourth way of increasing the tax take is to combat harmful tax practices. In this regard the OECD is pouring resources into a project specially focused on combating harmful tax practices. The project is called the Base Erosion and Profit Shifting Projects (BEPS). It is particularly focused on the question of multi nationals.

By way of background, after the First World War international trade increased dramatically. As a consequence of increased international trade the issue of double taxation began to become evident. Double taxation arises where the same income is taxed in two or more jurisdictions. For example a manufacturer of fridges may sell them in country A but be a corporation resident in country B. If country A and country B both have sourced based tax laws and residence based tax laws then the profit derived from the sale of the fridges in country A will be taxed by country A. It will also be taxed in country B because of that country’s law that world-wide income of a person resident in its jurisdiction is taxable by country B.

The reality of double taxation was universally agreed to be iniquitous. Accordingly in the 90 years or so since the end of the First World War a series of international treaties has been put in place whereby countries agree with one another which income each will tax and what recognition they will give of tax paid in the other country. These are called double tax treaties and are negotiated by the executive and then typically incorporated by reference into domestic law.

Over the last 90 years or so it has become increasingly apparent that there are two problems with this set of international treaties:

The first is corporate manipulation. Because the terms of the various treaties are not uniform, and because of the increased capital and personal mobility corporations in particular have been able to take advantage of the various treaties such that they effectively achieve double non-taxation. The most high profile example of that would be Google, which uses what is known as a “Double Dutch Sandwich” to pay very little tax on its international earnings.

The second is competition by countries for economic activity in their jurisdiction and the offering of tax concessions as a consequence. This competition can be seen in the international lowering of the corporate tax rates by countries over the last 50 years. Competition is driving the corporate tax rate towards zero.

Officials in New Zealand are participating with this OECD initiative. The first report from the OECD on the topic identified how corporates effectively achieve double non-taxation. The point of producing such a paper was so all countries could have a common understanding of what the problem was and how it arises.

Inland Revenue has just issued its second report updating as to progress with this international initiative. It reports that the OECD’s BEPS initiative is planning to release a paper containing an action plan. That is to be released by June 2013. The action plan is intended to identify actions needed to address BEPS, set deadlines to implement these actions, and identify the resources needed and the methodology to implement these actions.

Inland Revenue reports that it is likely that the action plan will contain the following:

Measures to put an end to or neutralise the effects of hybrid mismatch arrangements and arbitrage. The recent Court of Appeal decision Alesco dealt with a tax arrangement involving a hybrid instrument and the mismatch in tax treatments between jurisdictions. The cases of BNZ Investments Ltd v CIR (2009) 24 NZTC 23, 582 and Westpac Banking Corporation Ltd v CIR(2009) 24 NZTC 23, 834 are also examples of the use of hybrid financial instruments to make the most of the difference in tax treatments in different countries. The latter aspect is called international tax arbitrage.

Rules on the treatment of intra-group financial transactions, such as those related to the deductibility of payments and the application of withholding taxes.

Improvements or clarifications to transfer pricing rules to address specific areas where the current rules produce undesirable results from a policy perspective. The current OECD work on intangibles, which is a particular area of concern, would be included in a broader reflection on transfer pricing rules. The reason why intangibles are of such concern to officials is that they are a property right of choice in tax planning. This is because their ownership can be directed to anywhere in the world through documentation as opposed to needing physical plant, it can be subdivided into sub components again through contractual rather than physical means, and its value is difficult to objectively measure.

Updated solutions to the issues related to jurisdiction to tax, in particular in the areas of digital goods and services. These solutions may extend to a revision of treaty provisions. The taxation of digital services is vexing given the extant conceptual framework used to impose tax. In this regard the conceptual framework is really that of a 20th century industrial economy. The provision of digital services does not easily sit within that conceptualisation. Sub-issues with the digital economy are its impact on indirect taxes like GST. The internet enables goods to be purchased from supplies outside of New Zealand’s tax jurisdiction and then imported into New Zealand. Goods valued at less than $400 will not have GST imposed at the border. It will be readily apparent that such advances in digital technology place pressure on the New Zealand domestic retail industry and narrows the breadth of the GST tax base.

More effective anti-avoidance measures, as a complement to the previous items. Anti-avoidance measures can be included in domestic laws or included in international instruments. Examples of these measures include General Anti Avoidance Rules, Controlled Foreign Companies rules, Limitation of benefits rules and other anti-treaty abuse provisions.

Solutions to counter harmful regimes more effectively, taking into account factors such as transparency and substance.

Inland Revenue notes that some of the OECD proposals could be implemented by individual jurisdictions and others will need international cooperation to effect. Officials say that New Zealand is intending to work closely with Australia in developing their responses.

One particular response that Australia is considering is introducing a process for publication of the tax paid by Australian corporates with turnovers above certain thresholds. The idea is to provide incentives for what is considered to be good corporate behaviour – paying tax. The thinking is that public transparency as to the actual tax paid will exert a form of moral suasion on corporate taxpayers. The reason that transparency is being promoted in this way is that the public are by and large very unsupportive of large multi-nationals not paying tax in their jurisdiction.

It will be interesting to see how these initiatives develop.

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